Optimal Monetary and Macroprudential Policies under Fire-Sale Externalities

Author/Editor:

Flora Lutz

Publication Date:

March 10, 2023

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

I provide an integrated analysis of monetary and macroprudential policies in a model economy featuring a financial friction and a nominal wage rigidity. In this set-up, the monetary authority faces a trade-off between macroeconomic and financial stability: While expansionary counter-cyclical monetary policy prevents involuntary unemployment, it also amplifies an inefficient reallocation of capital across sectors. The main contribution of the analysis is threefold: First it highlights a novel channel through which monetary policy can impact financial stability. Second, it shows that, by itself, monetary policy can significantly mitigate the wedge between the constrained efficient and the competitive allocation. Third, regardless of the availability of macroprudential tools, stabilizing demand is usually not optimal for monetary policy.

Series:

Working Paper No. 2023/051

Frequency:

regular

English

Publication Date:

March 10, 2023

ISBN/ISSN:

9798400235191/1018-5941

Stock No:

WPIEA2023051

Pages:

53

Please address any questions about this title to publications@imf.org